MYTH OR REALITY? THE DIFFUSION OF FINANCIAL LIBERALIZATION IN DEVELOPING COUNTRIES

Over the past two decades, many developing countries have removed restrictions on the movement of capital flows across their borders. Diverging from existing studies of the determinants of financial openness which rely on decision-theoretic models that assume countries make decisions to liberalize independently of what other countries do, we consider an alternate explanation – namely that the decisions made by countries to liberalize are, in fact, very much interdependent. Using a new indicator of financial openness (FOI), we test the extent to which the decision to lift restrictions on capital and current account transactions has been diffused across countries in the developing world. Our paper makes three contributions to the growing body of literature on the diffusion of policies and practices in three ways. First, we recognize that the dependent variable – financial openness – is not a uniform policy and we take seriously the ways that support for liberalization might vary across individual categories of transactions. Second, we attempt to develop the logic underlying the causal mechanisms driving diffusion. Finally, empirically, most studies of financial openness focus almost exclusively on developed countries, when much of the radical liberalization, particularly in the 1990s, took place in the developing world. Here, we focus on diffusion in developing countries